Consolidation Shapes An Evolving Industry

February 2005

By Henry S. Kenyon

An industry report by the Civitas Group LLC indicates that the market for homeland-security-related products and applications continues to grow. Consolidation among security service providers is driving much of this expansion.

The homeland security market is undergoing a major shift away from individual products and systems to integrated, solutions-based offerings. A combination of business mergers and new technologies is the major force behind this change. Companies have consolidated critical sectors of the market, creating a business environment where broad suites of complementary services have an edge over narrowly focused products.

In the three years following the terrorist attacks in the United States, the commercial sector has moved to support the massive restructuring of the U.S. government. The centerpiece of these efforts is the U.S. Department of Homeland Security (DHS), which is the focus for private sector firms seeking contracts on research and procurement programs. Although initially swamped by thousands of applications to submit bids, creating a logjam that delayed programs and funding, the department has streamlined its procedures to increase the speed of future transactions. However, the market extends beyond the DHS and the government sector.

In a report, Civitas Group LLC seeks to correct what it believes are erroneous views about the market and to highlight ongoing trends, explains Mark Shaheen, vice president, Civitas Group. The company is a Washington, D.C.-based strategic advisory and investment services firm focused on the homeland security market. The attacks in 2001 did not create a new market but rather accelerated existing trends in the industry, he notes. These developments include increased growth and continuing consolidation as large systems integrators acquire smaller technology firms.

Shaheen believes that a dominant force in the market is a long-term shift from stand-alone products to an environment where packages of products and services are sold to multiple customers. Instead of providing an individual, narrowly focused solution and then having customers try to adapt their processes and collection of technologies to make that solution work for them, buyers are now requiring packaged services, he explains. For example, firms and government agencies used to contract with separate vendors for guard services, security cameras, access control systems and information technology security. These organizations now seek firms that integrate these different products and services.

The report finds that the homeland security market is very sensitive to setting standards that can be statutory, policy-based or industry-driven. While the U.S. government rarely defines explicit standards in this area, its actions often indirectly create de facto standards through the scale of its purchases. This can induce state, local, international and private sector buyers to adopt the same product or interface, the report concludes.

Another major factor affecting the market is its size and diffusion. The report notes that in the United States alone, more than 30,000 federal agencies and state, county and city governments are potential customers for security solutions. It finds that customer needs and market sophistication varies widely and that many firms are competing for business in the market’s different subsectors. But funds are available for firms seeking contracts. The report estimates that the total value of the global homeland security market in 2005 will be $42.4 billion. The United States will spend approximately $23.4 billion among federal, state, local and private organizations.

The report also finds that many of the nation’s security vulnerabilities occur in sectors with many participants, limited accountability and profit margins that discourage adequate security investment. For example, the 2002 strike by West Coast longshoremen cost the U.S. economy roughly $1 billion per day for its duration. However, these costs are minimal compared to the potential for damage caused by an attack on a major port such as the Los Angeles and Long Beach facilities, which receive approximately 34 percent of the nation’s shipping traffic. The report predicts that the potential economic impact of a nuclear attack on these ports could reach $1 trillion.

To protect these areas, government and private sector organizations must acquire the right technologies and services. Shaheen explains that the report divides the homeland security market into three generations of technologies. First-generation equipment and services existed before September 11, 2001, and were rapidly applied in large numbers to fill security gaps. These technologies are mainly traditional security applications such as surveillance cameras, barrier systems and metal detectors.

Second-generation technologies were in development at the time of the attacks or soon thereafter. These new systems are a major improvement on existing capabilities and are now beginning to be installed at facilities across the country, he explains. Examples of these technologies include holographic imaging systems that can detect ceramic or plastic weapons hidden under clothing, sensor integration and smart security camera technologies.

Third-generation equipment is still under development and will not be available in large quantities until 2008 or 2009. According to the report, many of the firms developing these technologies are small, privately held companies conducting advanced research with direct homeland-security-related objectives.

For a company to better understand its place in the homeland security market, its officers must determine where the firm’s products and services lie on the technology continuum, Shaheen relates. “Your strategy will be very different depending on what you have and where your technology is [in terms of development],” he says.

Shaheen predicts that purchases of first-generation equipment will begin to taper off in the near future. He notes that this does not mean markets will cease to exist for these basic technologies, adding that firms must use their research and development money to develop new products carefully and to position themselves well in an evolving market. That success hinges on many factors, he cautions, adding that having the best technology does not necessarily guarantee success. To succeed, firms must determine how their products fit into the larger market and find partners and distribution channels. These growth considerations are especially important for smaller companies. “In a lot of ways, this market is no different than any other market,” he says.

Roughly 70 to 80 percent of the critical infrastructure in the United States is controlled by the private sector, Shaheen observes. To prosper in this broad economic landscape, firms must understand their strengths and the products they are selling. “We see a lot of companies go about it in a very haphazard and opportunistic way. We think there’s a great benefit to actually sitting down, gauging the market and developing a real strategy before going after that market,” he shares.

These strategies can vary, but for smaller firms it often means forming teaming relationships with the right partners. Shaheen adds that major government contracts are usually going to be won by large companies, making teaming arrangements critical for smaller firms. Companies also are diversifying their customer base rather than relying solely on government customers. He notes that it is risky for small new firms to focus only on a single segment of the market.

The Civitas report finds that technologies, such as this fingerprint scanner, are more attractive to customers when they are provided as part of a bundled package of services.

Shaheen is quick to note that the Civitas Group does not pick stocks or back individual companies, but he predicts that several promising sectors will appear in the near future. These include sensor integration, smart video systems and video interpretation. “We’re not hysterical about the market, but we are very optimistic,” he says.

Among its findings, the report notes that systems integration will be a major revenue opportunity in aviation security as firms work to provide an information technology infrastructure for the Transportation Security Administration. The U.S. Coast Guard’s Deepwater Project also represents the largest long-term DHS project over the next decade and is a major business opportunity for maritime security. Ground transport security is another area of activity where planners are actively examining second- and third-generation technologies for explosives detection. Other opportunity areas include ongoing programs to develop nuclear and biological detection systems, data analysis and simulation tools for intelligence gathering, and systems to help law enforcement agencies coordinate operations.

Shaheen believes that the homeland security market is very robust. Although its growth potential has drawn some comparison to the dot-com boom of the late 1990s, he maintains that the two are very different markets. “This market is actually based on people building real products, and that’s a very good thing. I think that it has a very solid foundation of government research funding and procurement that will help to really smooth this market and stop wild fluctuations,” he says.

But a number of factors can still affect the market. If there is another major terrorist attack in the United States, the nature of that attack will influence spending and research decisions in those sectors of the market. For example, if explosives are used, either through a truck bomb or a Madrid-style train bombing, it would likely lead to increased research and procurement for explosives detectors focused on rail security. “All of these different things certainly have the ability to affect the market, and they are not predictable with any certainty,” he says.